India’s Accelerating Shift Toward Free Markets

By A. Gary Shilling -
Dec 17, 2012

For a half-century after gaining
independence in 1947, India’s politics were dominated by the
Congress Party’s socialist orientation and tilt toward the
Soviet Union.

In the 1950s, steel, mining, machine tools, water,
telecommunications, insurance, electricity generation and other
industries were effectively nationalized. The banks followed in
1969. The country’s first prime minister, Jawaharlal Nehru, also
pursued land redistribution.

Innovation was stifled by the Industries Act of 1951, which
required all businesses to obtain licenses from the government
before they could introduce, expand or change their products, a
system known as the “Licence Raj.” The government also imposed
import tariffs in the name of encouraging domestic production,
and Indian companies were prohibited from opening foreign
offices. Foreign investment dried up under stringent
restrictions and a labyrinthine bureaucracy.

As a result, manufacturing never blossomed and the economy
stagnated at what the economist Raj Krishna called the “Hindu
rate of growth” of 3 percent to 4 percent annually, distinctly
subpar for a developing economy and far lower than in other
Asian economies. From 1950 to 1973, annual growth in India was
3.7 percent, or 1.6 percent per capita, while Japan’s economy
grew 10 times faster, and South Korea’s five times
faster. China’s expanded at a sustained 8 percent annual rate.

State Enterprises

India’s economy began to change dramatically in 1991 with
the shift toward capitalism. In addition, India has historically
had a much more free-market orientation than some other large
developing countries, notably Russia and China. Its film
industry, Bollywood, freely cranks out movies that range in
quality from excellent to awful, while in China, films are
largely propaganda tools whose content is tightly controlled by
the government. State-controlled enterprises in India account
for 14 percent of gross domestic product, compared with about 50
percent in China.

India has the advantage, at least in our world of slow
growth and meager import demand in the U.S. and Europe, of being
much more domestically oriented than China and the other export-led countries in Asia. After independence, Indian leaders
advocated self-sufficiency and used high tariffs to keep out
imports in order to encourage local production.

India’s turn from socialism to capitalism, which culminated
in 1991, wasn’t voluntary; it was a consequence of severe
economic and financial pressures. In the 1980s, persistent
budget deficits forced the enactment of austerity policies. In
1991, a foreign-exchange crisis pushed the government to align
spending with revenue and move away from fixed exchange
rates. The rupee, which was overvalued and discouraged foreign
investment, fell. Led by Manmohan Singh, then finance minister
and now the prime minister, the government also opened the door
to foreign investment and Indian companies were allowed to
borrow in foreign capital markets and invest abroad. High
inflation was tamed. These new policies initiated the boom in
information technology.

At the same time, life expectancy jumped to 64 in 2008 from
58 in 1991. Literacy has risen. GDP per capita grew to $3,270 in
2009, from $925 in 1991. Airlines and telecommunications
companies were privatized.

Nevertheless, progress since the early 1990s has been
limited, as shown by the slower growth in India’s real GDP
compared with China’s. Also, India recently announced a five-year plan containing what is probably an unrealistic goal for
reducing the budget deficit to 3 percent in 2017, from 5.3
percent in the fiscal year ending March 31, 2013. The vague
proposal recalls the Soviet Union’s five-year plans that were
seldom met.

Cultural Forces

Change occurs slowly in India. Its culture has evolved over
millennia and is heavily influenced by Hindu philosophy, which
doesn’t emphasize urgency. According to Hindu belief, death is
followed by reincarnation. The process of birth and rebirth --
the transmigration of souls -- occurs until one achieves
“moksha,” or salvation. Hindus also believe in karma, which
holds that what one does in this life will have consequences in
the next, and what isn’t accomplished in this life can probably
get done later. Also, belief in predestination gives Hindus a
sense of fatalism.

Hinduism also incorporates other forms of belief and
worship. This creates a spirit of independence and a resistance
to authority that makes it difficult for the government to
enforce family planning and other policies. The chaos on Indian
roads -- where cars, trucks, ox carts, bicycles, rickshaws,
pedestrians and stray cows all compete for the right of way --
is an illustration of this independent spirit. The contrast with
the disciplined Chinese society, where family planning is
reinforced throughout the structure, is marked.

Nevertheless, the heat is on India’s leaders to move
quickly to reform an economy that is under pressure as it
struggles with ballooning deficits, sagging global growth, bad
policy decisions and declines of its currency and in foreign
direct investment.

(A. Gary Shilling is president of A. Gary Shilling & Co.
and author of “The Age of Deleveraging: Investment Strategies
for a Decade of Slow Growth and Deflation.” The opinions
expressed are his own. This is the second in a five-part series.
Read Part 1 and Part 3.)

To contact the writer of this article:
A. Gary Shilling at insight@agaryshilling.com